Skating on Thin Ice
Research for Online Investors

by John Dalt

1/6/10

Many of the things we learn in life help us be a better investor. Many of the investment ‘rules’ we learn help us in life also.  I visited with a subscriber this week about “penny stocks.” All of my paid subscribers know two things about our recommendations; we don’t do “penny stocks” or pharmaceuticals.

I’ll dispense with pharmaceutical companies first.  They are too volatile.  Every time I have gone against my better judgment, I learn the lesson again.  We owned Eli Lilly (LLY) in the long term portfolio back in 2009 and early 2010.  Whenever it seemed we had some momentum for a move higher, some piece of news would come out to destroy any enthusiasm for the company.  We sold at a nice profit, but I was glad to sell it.

Then, in the covered call service we bought Medivation (MDVN) a year ago.  It had a great premium on the covered call, and was in the middle of a final approval for an Alzheimer’s drug.  I thought we could enter and exit before the results came out.  A week after we entered the trade, leaks started raising concerns about the drug.  I probably don’t have to tell you we lost money on the trade, we took a shellacking.  This experience was good in the long run; we hunkered down on conservative recommendations and finished the year with a nice gain.

Penny stocks are an attractive nuisance.  I’ll probably get hate mail on this.  Who wants to tell me how much you have made on penny stocks?  But I will tell you this; you are gambling…you are not investing.  Show me a penny stock worth $0.80 per share that trades less than 50,000 shares a day.  I’ll find two traders with $100,000 bucks in their account and they can move that stock up and down like a yo-yo.

If you think it doesn’t happen, you’re not thinking.  If you play in this market, you are risking more than you know.  It may be a small amount, but the risks can be a 100% loss.  This is an ‘asymmetrical’ risk.  You may make 50 trades in this market with varying success, but one time you go home with nothing.  These are not investments, or trades, they are ‘bets.’

The first time I went to Vegas, my friend, Ernie, was stuck on playing Keno.  He thought it miraculous that he could bet one dollar and have a chance to win $25,000.  I can’t fault him, but penny stocks don’t give you those odds.  Ernie only risked one dollar for a big pay off, with penny stocks you risk everything in the trade, every time you enter the market and you don’t ever make a 25,000 to 1 return.  Those are not odds I like.

When I was a kid, dad had a saying to admonish us we were taking too big a risk.  He called it “skating on thin ice.”  In the ‘old wild west’ we would play hockey with the neighboring farm kids on the pond out in the pasture.  No, we didn’t have skates, hockey sticks or a puck.  We had overshoes, nailed together sticks from rough lumber and a tin can full of rocks for a puck.

It was all fun, until you heard the ice crack.  I can tell you that falling through the ice of a frozen farm pond on a windy 20 degree day when you were a half mile from home (and heat) was something to be feared.  If you wanted to live to play another day, you played with ears open and eyes on the ice.  I consider penny stocks the same sort of asymmetrical risk.  It is great, until it isn’t and then it can be very, very bad.

Our general rules are; minimum stock price of five dollars and volume in excess of 100,000 shares traded daily.  This should protect you from manipulation in the penny stock world.  We violate these rules occasionally, but never because of a hot tip from a phone call or direct mail piece (paid advertisement) telling us the secret this little company just discovered.  We have traded Citigroup (C), but volume of 500 million shares traded daily makes manipulation all but impossible, except for the Fed and their allies.

To the mailbag:
Just great, William Daly, more G?* D^%@ bankers in the White House---paid up subscriber T.M.

John’s reply:  Chicago mafia.

I am impressed with your skill on when to enter a trade. i.e. AGQ at <= $135.00  I sold at $157.00 and will wait for another set up to enter.---paid up subscriber E.H.

John’s reply: My skill at buying is a lot better than my skill at selling. That is the hardest part for me. $134 was good support, with the next line at $119 when we made that recommendation. We also said if it fell farther we might buy another position at $119 This was not to double down on a loser, but to get more money on the table for the winner. I just don't see what has changed to think that precious metals are not a good trade. I think you may get another chance to get in though.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

MarketToday Archive

Back to Top